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July 13, 2017

Mutual Funds: How Much Wisdom is There in the Crowd?

by Jake Moeller.

The “wisdom of the crowd” might for some be a reassuring phenomenon that can be readily applied to mutual fund investing. There is some sense to this; most investors are not fund experts, so a large and popular fund (in the absence of any other information about it) has probably had its tyres kicked enough times to act as some type of warranty.

Why do investors flock to the same funds?

There are many reasons for a fund or a fund house to be popular. Brand recognition, the effectiveness of its sales team, and its fund range are key as is availability on platforms and, unsurprisingly, historical performance. However, it is also true that many approved lists and guided architecture platforms have a very similar feel about them. Clearly, there are a number of the same funds that are appealing for a large number of gatekeepers—so those “tyres” have probably been diligently researched.

Exhibit 1. The Concentration of the U.K. Mutual Funds Market

Source: Thomson Reuters Lipper. Lipper for Investment Management.

Source: Lipper. Lipper for Investment Management.

For better or worse and likely for some of the reasons above, there is a high degree of investor concentration across funds in the U.K. Because of the vagaries of fund passports and domiciles, it is difficult to summarise regional fund markets precisely, but Lipper data suggest the U.K. fund “market” consists of some 3,800 funds (if you include closed funds with remaining assets), containing around £1.2 trillion of assets (as of April 30, 2017).

Considering these aggregated totals, concentration is clearly revealed. The largest 30 funds contain a fifth of the U.K.’s assets under management. Ranking all of these funds by April 2017 assets under management, 50% of the total U.K. asset base comprises only around 170 funds.

How have popular mutual funds performed?

The debate on the merits or otherwise of “blockbuster” funds is fodder for another article, but it is undeniable that the likes of SLI Gars, M&G Optimal Income, Invesco Perpetual High Income, Newton Real Return, and Woodford Equity Income have become names familiar to anybody in financial services.

We can take a snapshot of how the more popular funds are performing by considering the monthly rolling one-year performance deciles over five years (to month-end May 2017) and take the average of these to “score” each fund (1 is an excellent first decile average , 10 is a poor tenth decile average).

Of the 30 top funds by AUM in the U.K., 5 don’t have the requisite performance to score (although what data they do have scores them reasonably well), 7 are index funds (none of which scores above 5), and only 3 of those funds remaining score 4 or higher. This suggests that the recent performance of the most popular funds in the U.K. currently may not justify their investor commitment.

Safety in numbers? Not always

Such analysis has considerable limitations (individual investor experience differs according to entry point), but it certainly supports the more rigorous studies of fund size, which suggests that—for mutual funds at least—the gems may not always lie where the crowds are headed.

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